Philip Morris' dive unveiled lack of research, critics say

ANALYZING THE ANALYSTS

July 20, 1993|By Ian Johnson | Ian Johnson,New York Bureau

NEW YORK -- When Philip Morris announced earlier this year that it was slashing the price of its leading Marlboro cigarettes to compete with generic brands, Wall Street went into shock.

Analysts scrambled to change their recommendations on the consumer goods company. Portfolio managers unloaded shares. In one day, $13.4 billion in the company's stock value was wiped out.

While the debacle has highlighted Philip Morris' problems, it has also refocused attention on the analysts themselves. Critics charge that analysts' sometimes-cozy relations with the companies they cover blinds them to weaknesses and impending problems. Instead of providing an early warning, analysts often seem just to react to company press releases, critics say, allowing investors to be blindsided by bad company news.

The criticism comes at a time when the analysts' professional organization is making a concerted effort to raise analysts' training. Instead of plugging company-released numbers into a computer, predicting earnings and making recommendations, the Association for Investment Management and Research is encouraging analysts to ask harder questions and do more legwork before writing up a report on the companies they cover.

While applauding the effort to upgrade analysts' credentials, tougher critics of Wall Street see deeper problems.

One is that analysts largely depend on the goodwill of the companies they cover. A critical report by an analyst could mean that the analyst would be cut off from interviewing the company's management.

More seriously, most analysts are not independent judges of companies, but work for brokerages with a vested interest in publishing reports with a good spin, said Mark Fadiman, author of Rebuilding Wall Street. Analysts, for example, often write about the companies that their brokerages have underwritten or whose stock they are trying to sell.

"There is an incestuous relationship between research, sales and buyers. Analysts have to come up with ideas and usually those have to be positive ideas," Mr. Fadiman said. "As long as this relationship exists, no amount of professional training will help 00 make analysts more independent or insightful."

bTC A combination of these factors may well have contributed to Wall Street's debacle on April 2, when the Street stampeded to sell stock of Philip Morris Cos. Inc. in a near-panicky haste.

Ample warning signs

Industry observers outside Wall Street pointed to several warning signs of Philip Morris' trouble.

They noted the Clinton administration had been discussing higher taxes on two big Philip Morris products, alcohol and tobacco, since February; the company had already been experimenting for more than a month with low-priced cigarettes in Oregon; at least one prominent money manager, who was featured on the cover of Barron's, had already been short-selling the stock; and, even the company itself had warned in its annual report that it faced intensified price competition this year.

Despite this wealth of skepticism about Philip Morris' near-term prospects, Wall Street's analysts continued to recommend buying the stock. According to a survey of 27 analysts by Zacks Investment Research in Chicago, 21 recommended buying the stock before its fall, five recommended holding it, and only one advised selling.

Then, on the day Philip Morris' stock tumbled, nine of the analysts reversed themselves, advising their clients to sell the stock -- at a two-year low.

At Wheat First Butcher & Singer, for example, analyst John C. Maxwell had a buy on the company until the stock opened April 2, down $14. He quickly pulled the stock off his buy list and now says he isn't sure what the company's prospects are.

"It was a surprise to everyone what happened that day. Now there's too much turmoil for a rating," said Mr. Maxwell, ranked a top-performing analyst by Institutional Investor magazine.

Other recent examples of analysts being caught flatfooted include Apple Computer Inc.'s announcement last week that it lost $188.3 million for the most recent three-month accounting period and International Business Machines Inc.'s announcement in December that it would shed 25,000 jobs this year. In both cases, many analysts revised estimates far too late to be of any use to investors and failed to provide much warning of the companies' problems.

Lack of 'fundamentals'

The analysts involved in these cases refused to discuss their actions, but other analysts say the problem may stem from a lack of training in fact-driven "fundamental" research.

Cindy Mezy, a fundamental analyst with PNC Bank in Philadelphia, said the 1980s stock-market boom helped downplay the value of old-style gumshoe analysts who did original research on individual companies.

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